UTILITY MAXIMIZATION PRINCIPLE OR LAW OF EQUI-MARGINAL UTILITY

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Presentation on theme: "UTILITY MAXIMIZATION PRINCIPLE OR LAW OF EQUI-MARGINAL UTILITY"— Presentation transcript:

1 UTILITY MAXIMIZATION PRINCIPLE OR LAW OF EQUI-MARGINAL UTILITYR.G.Lipsey Says, " The household maximising is utility will allocate his expenditures between commodities in such a way that the utility of the last penny spent on each is equal." Every consumer will substitute the more useful for the less useful thing. This law is also known as the law of substitution. It is called the law of Equi-Marginal Utility because it is only law by which the marginal utilities have been equalised through the process of substitution. This law can be explained with the help of following schedule, assuming that our consumer has only Rs. 5/- to spend. Further it is assumed that there are two commodities Apple and Orange.

2 Every consumer will substitute the more useful for the less useful thing. This law is also known as the law of substitution. It is called the law of Equi-Marginal Utility because it is only law by which the marginal utilities have been equalised through the process of substitution. This law can be explaind with the help of following schedule, assuming that our consumer has only Rs. 5/- to spend. Further it is assumed that there are two commodities Apple and Orange.

3 According to this schedule if one consumer spends his RsAccording to this schedule if one consumer spends his Rs. 5/- on one thing then he will get only 30 or 20 units of satisfaction. To get maximum satisfaction a consumer will spend Rs. 3/- on Apple and Rs. 2/- on Orange. Because in this way the total amount of utility will be maximum. When a consumer will spend Rs. 3/- on Apple he will get = = 24 By spending two rupees on Oranges he will get = = 14 Total amount of satisfaction will be = 38 If he will adopt any other method, he would not get such amount of utility. So we find that when the marginal utilities ( 6 = 6 ) are equal the total utility is maximum. No combination will give him more satisfaction except this one.

5 EXPLANATION :- In this diagram MM' is the marginal utility curve of Apple. If consumer spends Rs. 3/- on Apple. The 3rd rupees utility is FG, KK' the marginal utility curve of orange. The last rupee utility is HJ. Both the marginal utilities FG = HJ. LIMITATIONS OF THE LAW OF EQUI MARGINAL UTILITY 1. Unmeasurable concept :- The concept of utility is unmeasurable so it is very difficult to behave according to the law. 2. Carelessness :- Sometimes due to ignorance people do not obtain the maximum advantage by equating the marginal utilities. 3. Indivisible units :- If the unit of expenditure is indivisible then this law will not operate. 4. Customs :- People are slave of customs and traditions, so they use the goods like gold even there is less utility. 5. Freedom of choice :- If there is no perfect freedom to choose between various commodities, then the law will not operate.

6 Practical Importance The law of equi- marginal utility has wide practical importance. 1. Consumer behaviour: In spite of limitations, every consumer, consciously or unconsciously tries to act according to this principle n spends his income in such a way that total satisfaction is max Producer Policy: Every producer tries to use the most economical combination of factors. He achieves this goal when he makes the marginal productivity of factors equal ( that is he substitutes more productive factor for less productive one. 3. Rewards of factors of production: That is rent of land, wages of labour, interest of capital and profit of the firm are all determined according to the law of marginal productivity. If the marginal product of a factor is relatively higher than that of another the entrepreneur tries to substitute with another. The producer tries to equalise marginal productivity of all factor inputs. 4. Exchange of goods is also done on this principle: People exchange a commodity whose utility is less for a commodity with a commodity with higher utility. Exchange of goods stops when marginal utilities become equal.